TY - JOUR
AU - Abel,Andrew B.
AU - Eberly,Janice C.
TI - Optimal Investment with Costly Reversibility
JF - National Bureau of Economic Research Working Paper Series
VL - No. 5091
PY - 1995
Y2 - April 1995
DO - 10.3386/w5091
UR - http://www.nber.org/papers/w5091
L1 - http://www.nber.org/papers/w5091.pdf
N1 - Author contact info:
Andrew B. Abel
The Wharton School
University of Pennsylvania
2315 Steinberg Hall - Dietrich Hall
Philadelphia, PA 19104-6367
Tel: 215/898-4801
Fax: 215/573-7244
E-Mail: abel@wharton.upenn.edu
Janice C. Eberly
Department of Finance
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston, IL 60208
Tel: 847/467-1840
Fax: 847/491-5719
E-Mail: eberly@kellogg.northwestern.edu
AB - Investment is characterized by costly reversibility when a firm can purchase capital at a given price and sell capital at a lower price. We derive an explicit analytic solution for optimal investment by a firm facing costly reversibility. In addition, we derive a local approximation to the solution which highlights the effects of the parameters of the problem on the triggers for investment. More generally, we extend the Jorgensonian concept of the user cost of capital to the case of uncertainty and define cU and cL as the user costs of capital associated with the purchase and sale of capital, respectively. Optimality requires the" firm to purchase and sell capital as needed to keep the marginal revenue product of capital in" the closed interval [cU,cL]. This prescription encompasses the case of irreversible investment as well as the standard" neoclassical case of costlessly reversible investment. Finally, quantitative analysis suggests" that even when the difference between the purchase and sale prices of capital is small user costs associated with purchasing and selling capital are closer to those applicable under" complete irreversibility than to those applicable under costless reversibility."
ER -